Breaking down the fiduciary rule’s impact on robo-advisers
In the wake of the Department of Labor’s fiduciary rule that went into effect last week, all retirement investment advisers must work in the best interest of their clients. This even extends to robo-adviser firms, explains Seth Rosenbloom, general counsel of robo adviser firm Betterment. What follows is an edited version of the conversation.
EBA: Does the Department of Labor’s new fiduciary rule cover robo-advisers?
Seth Rosenbloom: Absolutely. This is something that the Department of Labor has been outspoken about since the rule was first proposed, and even before it was finalized they talked about the potential of digital advice to give low-cost, quality fiduciary advice. [The DOL has done this] both in terms of their public statements and actually the preamble of the rule itself talks quite a bit about digital advice being subject to the same fiduciary standards.
EBA: Can a robo-adviser determine what the best interests of a client are?
Rosenbloom: I don't think there's any reason why robo-advisers are different than more traditional advisers when it comes to the need to [determine a client’s best interest.]
One thing that people who were critical of robo-advisers, they underestimate the involvement of human professionals in devices delivered digitally and the involvement of software in traditional advisory services. Regardless of whether something is labeled as the robo-adviser versus another type of adviser, the underlying challenges are the same. Either delivery model is equally capable of giving good advice, which is ultimately what the best interest standard is all about.
EBA: What is the best interest standard and why is this important to benefit advisers?
Rosenbloom: There's a few components of what the best interest standard ultimately requires. One is the duty of loyalty — that's putting the interest of the client above your own financial interest, and certainly there's no reason why a digital adviser would in any way be less able to do that than a human adviser. To the contrary, it is actually much easier to program software to not put its own interests or the interests of a firm ahead of a client's. And it's much easier to take a look at that software to determine whether it actually is putting the client’s interest first.
Then, there's the duties of prudence and individualization that are probably the second and the third components of the best interest standard as it's properly understood. Prudence goes to that: Are you gathering enough information and the right information about the client and then are you giving quality advice that reflects the information that you can collect?
EBA: If the robo-adviser makes a poor investment or if it can be determined that they haven't acted in the best interest of the client, who's responsible? Would it be the third party that wrote the software or would it be the investment firm itself?
Rosenbloom: Usually, it is the firm itself. It’s a business and it gets very technical and legal [but] it's the same question at some level in a traditional firm. If you're dealing with an individual who works for Fidelity or Vanguard and they give you bad advice [then] the firm is responsible. Similarly, if you're dealing with software that's created by a firm, ultimately the firm is responsible for the software.
EBA: Sometimes algorithms behave oddly and are susceptible to their own their own quirks. What does a client do if they find out that an algorithm has gone rogue and wiped out a portfolio?
Rosenbloom: Regardless of what type of firm that you're dealing with these days, any advisory firm is using a ton of technology that may or may not be visible to the client. Traditional advisers are still using software to manage their trades and rebalance a host of functions. It would be incredibly inefficient and otherwise negligent probably not to be using technology, given certain states of what's available and the errors that could be made you weren't heavily relying on technology.